Health care in America

Reconstructive surgery

Caught in the cross-currents of conflicting goals, erratic government policy and costly changes in technology, America’s philanthropically organised community hospitals are going the way of the family farm

TO GET a sense of how the business of delivering medicine in America fluctuates between utter disaster and extraordinary business opportunity, consider the case of Sharon Hospital in Connecticut, one of America's 4,300 non-profit hospitals. Along with superb demographics—it is in one of the richest counties in one of America's richest states—Sharon benefits from being almost an hour away from competing institutions. Go into labour or crash your car in north-western Connecticut, and it is the obvious choice for care.

Providing a necessary service with little competition should surely guarantee success. But recent results argue otherwise. The hospital has lost $10m in the past three fiscal years. Revenues are stagnant, costs are growing and mounting losses make it increasingly hard to finance expensive new equipment. Sharon, in short, is on life support. Nor is it alone: change a few details and the story is being repeated throughout America.

Over the past decade, 10% of America's community hospitals have closed, even as an ageing population is demanding ever more health care. Many of the surviving hospitals are in poor shape. Their operating margins are less than 3% on average, a level that cannot hope to cover capital costs; and their debt is being downgraded as never before (see chart). Given the fragile state of the business, the only surprise is that more hospitals do not close. Of Connecticut's 31 full-service hospitals, Sharon officials say a third are losing money and several could fail.

The main problem facing hospitals is a business environment that has been made unforgiving as both government and business seek to control health-care costs. The easiest place to begin was with revenues. In 1997, Congress was justifiably terrified by the prospect of an insolvent Medicare—the main health-insurance scheme for the elderly and the source of half of all hospital income—so it cut the programme's reimbursements to hospitals. Less justifiably, it allowed the Medicare rulebook to swell to 45,000 pages.

If the government was tough, the private sector has become even tougher. Businesses of all sorts have shifted medical coverage to health-management organisations that, according to their critics in the industry, reimburse hospitals based on three strategies: low pay, slow pay and no pay. Merely qualifying for reimbursement requires mastery of a staggering number of contractual arrangements. Hospitals in densely populated areas may accept as many as 200 different company health-care plans.

If that were not enough, the value provided by hospitals has also shifted. Beds are out; high-tech equipment for imaging, non-invasive surgery, digital mammograms and the like is in. This transformation requires money and vision. Like many other hospitals, Sharon lacked at least one of these attributes, if not both.

Last June it took a radical step, agreeing to be bought by Essent Healthcare, a new, for-profit institution. Although for-profit hospitals are common in the south and west, they still amount to less than 15% of the industry, by number of hospitals, and are particularly sparse on the east coast. New York has gone so far as to outlaw ownership of hospitals by publicly traded companies.

One concern over deals such as Sharon's is that if a municipal institution cannot now break even, how can it produce enough profit in future to satisfy an investor? There are also fears that profits may detract from care. The state of Connecticut, which must review the deal, has asked for information on the hospital's property holdings, presumably to understand whether the transaction is a thinly veiled liquidation.

As is also typical in privatisations, the sale of Sharon is awkward. Any approval by regulators is months away. The purchase price, $16m, has strings attached. In a move that would be unacceptable in the sale of most companies, the consultancy handling the deal, Cambio Health Solutions of Tennessee, is also providing a temporary chief executive. Her approach to routine business matters such as bill collection will have a big impact on the final price.

Given these impediments, it would not be a surprise if Sharon were merely allowed to close. That the deal remains alive in spite of such problems reflects another odd fact: most hospitals may be struggling, but they can in principle be turned into extraordinarily profitable businesses.

The evidence comes in the results of shareholder-owned hospital operators. During 2000, a horrendous year on Wall Street, shares of these outfits more than doubled. Their operating margins range from 13% to 24%. Essent's main financial backer is Thoma Cressey, a Chicago buy-out firm that boasts annualised returns of 30%. Its partners have done particularly well out of early investments in two publicly traded hospital companies, Province Healthcare and Health Management Associates.

The factors behind the success of for-profit hospitals are controversial. They may scrap research—not a big department at Sharon, but costly at larger hospitals. They may also take a harsh line against providing charitable care for the poor, although Essent has promised not to do so. HCA Healthcare, the largest for-profit chain, has admitted charges of Medicare-related fraud, among other problems, and paid almost $1 billion in penalties in a series of cases stretching out over the past five years.

The best argument for the profit motive, however, is that increasingly complicated institutions demand increasingly sophisticated management. Inventory control, price negotiations with suppliers, processing patients and financing new equipment are all tricky tasks. Pushing Sharon's costs down to the standards of for-profit hospitals would, Essent estimates, save $5m a year, eliminating its operating loss. Luring local residents who go elsewhere for non-urgent care could add another $3m to the bottom line. As hospitals have substantial fixed costs, incremental business can bring large returns.

More than two dozen American hospitals were privatised last year. That number is expected to rise. In December, a municipally owned institution in Haverhill, Massachusetts announced that it faced potential ruin, echoing earlier cries in, among other states, Ohio, Missouri and Alabama. The federal government may be pumping in a bit more money, but the next crisis is never far away. A decade from now, it would not be surprising if all non-profit hospitals, except those with generous patrons or unusually competent management, were closed or sold.